TreasuryOne Monthly Report and Forecast
With what can only be described as an interesting January, to say the least, it’s time to take stock and reflect on what has happened in the markets since the start of the year and contemplate what could happen going forward in the short, medium and long term. Thus far, a few established drivers of the market have been identified:
1) The US dollar continues to be the driver of the currency market
2) The impact of the new US administration on markets
3) The Corona vaccines and the efficiency of the roll-out thereof.
4) The US and European Central Banks mantra of lower for longer
However, a couple of new drivers have emerged in January that needs to be watched as it may have a bigger impact down the line.
5) The current retail investor induced volatility in the market
6) Trouble in the Chinese Repo market
We have to remember that not one of the above drivers is bigger than the sum of all parts. Discussing the drivers individually, we will miss the contagion effect that each one has on the other—a symbiotic relationship of sorts.
The new player in the major drivers is the recent US presidential administration that officially started their work in the middle part of January. Leaving all the political drama out and focusing just on the economic side of the coin, some key decisions have been made. One of the first was appointing former Fed Chair Janet Yellen to the position of Treasury Secretary. Yellen is a known dove and has never been shy about her quantitative easing proclivity, which brings us to our next point.
President Biden wants to inject a relief package to the tune of 1.9 trillion dollars as a stimulus package for COVID relief, and this needs to be funded. With Yellen, in a position of power, the bets are on QE rather than hiking taxes. The stimulus package will only be approved in March at the earliest, and the size could vary from Biden’s initial amount, but what does this mean for the US dollar.
The fallout from QE is usually a weaker US dollar, and we have seen that prominent people have been talking the US dollar down for the past few months. The fall in the US dollar has been steady rather than spectacular and should new stimulus be announced we could expect the US dollar to slide further. We think that the gradual slide in the US dollar has been down to the rise of longer-dated US Treasury yields as higher rates are generally good for a currency, and the US dollar will probably strengthen in the longer term due to this but at the short end of the curve its skewed towards dollar weakness.
The other partner in the US dollar marriage is the COVID pandemic and the roll-out of the vaccine. We have seen with any positive news on the pandemic that Emerging Markets (EM) gets a shot in the arm while the US dollar loses some ground. This seems to be the default setting for the market, but it only takes a couple of negative headlines to throw over the apple cart. The COVID vaccine will bring volatility into the market and is a headline that we will be keeping our eye on in short to medium term.
Of the new factors, the current hot topic is the “short squeezing” of retail investors in the equity and commodity space. In the past couple of days, we have seen stock like GameStop and Silver trading wildly on the back of retail investors trying to squeeze hedge funds out of short positions. So far, we have not seen a lot of contagion into the FX market, but the longer it continues, the more likely it can become. The rise of the retail investors brings a yo-yo effect to risk sentiment; in the past couple of days, it has been jostling between “risk-on” and “risk-off” constantly. Interesting, the VIX index, which is the fear index, jumped by the most in 3 years at one stage last week. When fear gets high, you run to the dollar, and while the market wants a weaker US dollar, the opposite can happen should there be fallout from Wall Street.
Another interesting factor to keep our eye on is the Chinese Repo rate that shot up to record levels as the Peoples Bank of China withdrew $ 12 billion worth of Yuan out of the market during last week. The Repo rate has recovered to previous levels as the PBOC injected $ 15 billion worth of Yuan back into the market late on Friday. This has caused a bit of a shudder through the market, and although it has calmed down if China goes into a repo crisis, the effect on the world market and EM currencies could be devastating.
While all these market movements are going on, what does this mean for the Rand? Currently, the Rand has moved along with its EM peers and has traded in a very narrow band for the last couple of weeks as we await momentum from abroad, and with the US dollar, toing and froing none has been forthcoming.
There is an argument to be made that the Rand could trade stronger in the short terms, especially in light of the US planning new stimulus and South Africa being one of the last vestiges of yield, hot money could flow into the country. This could be true, especially with the MPC of the Reserve Bank stating that the next interest rate moves should be higher. Should there be an extended risk rally the Rand could benefit from that but while the short term looks rosy the longer term could be a little bleaker.
Local South African factors like our spiralling debt, the roll-out of the COVID vaccine, and the tough love we are in for during our budget speech have the real possibility that South Africa could decouple from EM peers. And then we might lose some of the fortunes of being in a “risk-on” rally. Most of the debt incurred is foreign-denominated and to make debt cheaper a weaker Rand would be a boon to pay back the debt. Still, a weaker currency leads to other economic issues like inflation and higher interest rates. Thus, in the longer term, there could be a rough road ahead for South Africa.
With the Rand currently in very tight ranges in the short term, we would cover any import obligation at levels below the R15.00 market and exporters should look at spikes above R15.40 to offload dollars or put strategies in place to possibly offload dollars at weaker levels in the longer term.